Prudential Norms on Capital Adequacy for Urban Co-operative Banks

RBI/2022-23/13 DOR.CAP.REC.2/09.18.201/2022-23 April 1, 2022 The Chief Executive Officers All Primary (Urban) Co-operative Banks Dear Sir / Madam, Master Circular - Prudential Norms on Capital Adequacy - Primary (Urban) Co-operative Banks (UCBs) Please refer to our Master Circular DCBR.BPD.(PCB).MC.No.10/09.18.201/2015-16 dated July 01, 2015 on the captioned subject. 2. The enclosed Master Circular consolidates and updates all the instructions / guidelines on the subject issued up to March 31, 2022 as listed in the Appendix . Yours faithfully (Usha Janakiraman) Chief General Manager Encl: As above Master Circular Prudential Norms on Capital Adequacy - Primary (Urban) Co-operative Banks (UCBs) Contents

1. Introduction Capital acts as a buffer in times of crisis or poor performance by a bank. Sufficiency of capital also instills depositors' confidence. As such, adequacy of capital is one of the pre-conditions for licensing of a new bank as well as its continuance in business.
2. Statutory Requirements In terms of the provisions contained in Section 11 of Banking Regulation Act (AACS), no co-operative bank shall commence or carry on banking business unless the aggregate value of its paid-up capital and reserves is not less than one lakh of rupees. In addition, under Section 22(3)(d) of the above Act, the Reserve Bank prescribes the minimum entry point capital (entry point norms) from time to time, for setting-up of a new Primary (Urban) Cooperative Bank.
3. Capital Adequacy Norms Reserve Bank of India has broadly mandated the Basel-I Framework for Primary (Urban) Co-operative Banks in India. Accordingly, they shall maintain a minimum Capital to Risk Weighted Assets Ratio (CRAR) of 9% on an ongoing basis. The capital funds for capital adequacy purposes shall consist of Tier I and Tier II capital as defined below. The total of Tier II capital shall be limited to a maximum of 100 per cent of total Tier I capital for the purpose of compliance with CRAR norms. Risk weights for different categories of exposures of banks are outlined in Annex-I . 3.1 Tier I Capital Tier I shall comprise the following: Paid-up share capital 1 collected from regular members having voting rights. Contributions received from associate / nominal members where the bye- laws permit allotment of shares to them and provided there are restrictions on withdrawal of such shares, as applicable to regular members. Contribution / non-refundable admission fees collected from the nominal and associate members which is held separately as 'reserves' under an appropriate head since these are not refundable. Perpetual Non-Cumulative Preference Shares (PNCPS), which comply with the regulatory requirements as specified in Annex-II . Free Reserves as per the audited accounts. Reserves, if any, created out of revaluation of fixed assets or those created to meet outside liabilities should not be included in the Tier I Capital. Free reserves shall exclude all reserves / provisions which are created to meet anticipated loan losses, losses on account of fraud etc., depreciation in investments and other assets and other outside liabilities. For example, while the amounts held under the head "Building Fund" will be eligible to be treated as part of free reserves, "Bad and Doubtful Reserves" shall be excluded. Capital Reserves representing surplus arising out of sale proceeds of assets. Perpetual Debt Instruments (PDIs) which comply with the regulatory requirements as specified in Annex-III . Any surplus (net) in Profit and Loss Account i.e., balance after appropriation towards dividend payable, education fund, other funds whose utilisation is defined, asset loss, if any, etc. Outstanding amount in Special Reserve created under Section 36(1) (viii) of the Income Tax Act, 1961. Note : (i) Amount of intangible assets, losses in current year and those brought forward from previous periods, deficit in NPA provisions, income wrongly recognized on non-performing assets, provision required for liability devolved on bank, etc. will be deducted from Tier I Capital. (ii) For a Fund to be included in the Tier I Capital, the Fund should satisfy two criteria viz., the Fund should be created as an appropriation of net profit and should be a free reserve and not a specific reserve. However, if the same has been created not by appropriation of profit but by a charge on the profit then this Fund is in effect a provision and hence will be eligible for being reckoned only as Tier II capital as defined below and subject to a limit of 1.25% of risk weight assets provided it is not attributed to any identified potential loss or diminution in value of an asset or a known liability. (iii) Outstanding Innovative Perpetual Debt Instruments (IPDI) which were issued in terms of Annex to circular UCB.PCB.Cir.No.39/09.16.900/08-09 dated January 23, 2009 shall also be eligible to be reckoned as Tier-I capital subject to the ceilings prescribed in Annexes to this Master Circular. It may be noted that the Annex to circular dated January 23, 2009 has since been repealed vide circular No. DOR.CAP.REC.92/09.18.201/2021-22 dated March 08, 2022 , and with effect from March 08, 2022, amount issued through PDI by conversion of existing deposits as part of revival plan/ financial reconstruction of the UCBs (in terms of circular dated January 23, 2009) shall comply with the Annex-III of this Master Circular. 3.2 Tier II Capital Tier II capital shall comprise the following: 3.2.1 Revaluation Reserves These reserves often serve as a cushion against unexpected losses, but they are less permanent in nature and cannot be considered as 'Core Capital'. Revaluation reserves arise from revaluation of assets that are undervalued in the bank's books. The typical example in this regard is bank premises and marketable securities. The extent to which the revaluation reserves can be relied upon as a cushion for unexpected losses depends mainly upon the level of certainty that can be placed on estimates of the market value of the relevant assets, the subsequent deterioration in values under difficult market conditions or in a forced sale, potential for actual liquidation of those values, tax consequences of revaluation, etc. Therefore, it would be prudent to consider revaluation reserves at a discount of 55% when determining their value for inclusion in Tier II Capital i.e. only 45% of revaluation reserve should be taken for inclusion in Tier II Capital. Such reserves will have to be reflected on the face of the balance sheet as revaluation reserves. 3.2.2 General Provisions and Loss Reserves These would include such provisions of general nature appearing in the books of the bank which are not attributed to any identified potential loss or a diminution in value of an asset or a known liability. Adequate care must be taken to ensure that sufficient provisions have been made to meet all known losses and foreseeable potential losses before considering any amount of general provision as part of Tier II capital as indicated above. To illustrate: General provision for Standard Assets, excess provision on sale of NPAs etc. could be considered for inclusion under this category. Such provisions which are considered for inclusion in Tier II capital will be admitted up to 1.25% of total weighted risk assets. As per the extant instructions, provisions made for NPAs as per prudential norms are deducted from the amount of Gross NPAs to arrive at the amount of Net NPAs. The prudential treatment of different type of provisions and its treatment for capital adequacy purposes is given below:

• (a) Additional General Provisions (Floating Provisions) Additional general provisions (floating provisions) for bad debts i.e., provisions not earmarked for any specific loan impairments (NPAs) may be used either for netting off of gross NPAs or for inclusion in Tier II capital but cannot be used on both counts.
• (b) Additional Provisions for NPAs at higher than prescribed rates In cases where banks make specific provision for NPAs in excess of what is prescribed under the prudential norms, the total specific provision may be deducted from the amount of Gross NPAs while reporting the amount of Net NPAs. The additional specific provision made by the bank will not be reckoned as Tier II capital.
• (c) Excess Provisions on transfer of stressed loans to Asset Reconstruction Companies (ARC) In terms of instructions issued vide Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 dated September 24, 2021 , when the stressed loan is transferred to ARC at a price higher than the Net Book Value (NBV) at the time of transfer, UCBs shall reverse the excess provision on transfer to the profit and loss account in the year the amounts are received and only when the sum of cash received by way of initial consideration and / or redemption or transfer of Security Receipts (SR) / Pass Through Certificates (PTCs)/ other securities issued by ARCs is higher than the NBV of the loan at the time of transfer. Further, such reversal shall be limited to the extent to which cash received exceeds the NBV of the loan at the time of transfer. Until reversal, such excess provisions shall continue to be shown under 'provisions' and would be considered as Tier II capital subject to the overall ceiling of 1.25% of risk weighed assets.
• (d) Provisions for Diminution in Fair Value Provisions for diminution in the fair value of restructured accounts, both in respect of standard assets and NPAs, are permitted to be netted from the relative loan asset and will not be reckoned as Tier II capital. 3.2.3 Investment Fluctuation Reserve Balances in the Investment Fluctuation Reserve created out of appropriation of net profit from the realised gains from the sale of investments held in AFS & HFT can be reckoned as Tier II capital. 3.2.4 Tier-II capital instruments UCBs may issue the following instruments to augment their Tier-II capital:
• a) Upper Tier-II instruments - Perpetual Cumulative Preference Shares (PCPS), Redeemable Non-Cumulative Preference Shares (RNCPS) and Redeemable Cumulative Preference Shares (RCPS) which comply with the regulatory requirements as specified in Annex-II .
• b) Lower Tier-II instruments - Long Term Subordinated Bonds (LTSB) which comply with the regulatory requirements as specified in Annex-III . Note: Outstanding Long Term (Subordinated) Deposits (LTD) which were issued in terms of Annex-II to the circular UBD.PCB.Cir.No.4/09.18.201/08-09 dated July 15, 2008 , and subsequent amendments thereto, shall also be eligible to be reckoned as Tier-II capital subject to the ceilings prescribed in Annex-III to this Master Circular. It may be noted that the circular dated July 15, 2008 has since been repealed vide circular No.DOR.CAP.REC.92/09.18.201/2021-22 dated March 08, 2022 .

4. Capital for Market Risk 4.1 Market risk is defined as the risk of losses in on-balance sheet and off- balance sheet positions arising from movements in market prices. The market risk positions, which are subject to capital charge are as under: The risks pertaining to interest rate related instruments and equities in the trading book; and Foreign exchange risk (including open position in precious metals) throughout the bank (both banking and trading books). 4.2 As an initial step towards prescribing capital requirement for market risks, UCBs were advised to assign an additional risk weight of 2.5 per cent on investments. These additional risk weights are clubbed with the risk weights prescribed for credit risk in respect of investment portfolio of UCBs as per Annex-I , and banks are not required to provide for the same separately. Further, UCBs are advised to assign a risk weight of 100% on the open position limits on foreign exchange and gold, and to build up investment fluctuation reserve as per extant instructions. 4.3 UCBs having AD Category I licence are required to provide capital for market risk in terms of circular UBD.BPD(PCB)Cir.No.42/09.11.600/2009-10 dated February 8, 2010 .
5. Share linking to Borrowings Borrowings from UCBs shall be linked to shareholdings of the borrowing members as below: 5 per cent of the borrowings, if the borrowings are on unsecured basis. 2.5 per cent of the borrowings, in case of secured borrowings. In case of secured borrowings by Micro and Small Enterprises (MSEs), 2.5 per cent of the borrowings, of which 1 per cent is to be collected initially and the balance of 1.5 per cent is to be collected in the course of next 2 years. The above share linking norms may be applicable for member's shareholdings up to the limit of 5 per cent of the total paid up share capital of the bank. Where a member is already holding 5 per cent of the total paid up share capital of a UCB, it would not be necessary for him / her to subscribe to any additional share capital on account of the application of extant share linking norms. In other words, a borrowing member may be required to hold shares for an amount that may be computed as per the extant share linking norms or for an amount that is 5 per cent of the total paid up share capital of the bank, whichever is lower. Share-linking to borrowing norms shall be discretionary for UCBs which meet the minimum regulatory CRAR criteria of 9 per cent and a Tier 1 CRAR of 5.5 per cent as per the latest audited financial statements and the last CRAR as assessed by RBI during statutory inspection. Such UCBs shall have a Board-approved policy on share-linking to borrowing norms which shall be implemented in a transparent, consistent and non-discriminatory manner. The policy may be reviewed by the Board at the beginning of the accounting year. UCBs, which do not maintain the minimum CRAR of 9 percent and Tier 1 CRAR of 5.5 per cent, shall continue to be guided by the norms on share-linking to borrowing as specified above. Perpetual Non-Cumulative Preference Shares (PNCPS) held by members / subscribers, may be treated as shares for the purpose of compliance with the extant share linking to borrowing norms.
6. Refund of share capital In terms of Section 12 (2) (ii) read with Section 56 of the BR Act, a co-operative bank shall not withdraw or reduce its share capital, except to the extent and subject to such conditions as the Reserve Bank may specify in this behalf. Accordingly, it has been decided to permit UCBs to refund the share capital to their members, or nominees / heirs of deceased members, on demand 2 , subject to the following conditions:

• a) The bank’s CRAR is 9 per cent or above, both as per the latest audited financial statements and the last CRAR as assessed by RBI during statutory inspection.
• b) Such refund does not result in the CRAR of the bank falling below regulatory minimum of 9 per cent. For the purpose of computing CRAR as above, accretion to capital funds after the balance sheet date 3 , other than by way of profits, may be taken into account. Any reduction in capital funds, including by way of losses, during the aforesaid period shall also be considered.

7. Measures for protection of investors in regulatory capital instruments specified in Annex-II and Annex-III For the purpose of enhancing investor education on the risk characteristics of regulatory capital instruments, UCBs, which issue regulatory capital instruments specified in Annex-II and Annex-III shall adhere to the following conditions:

• a) For floating rate instruments, banks should not use its Fixed Deposit rate as benchmark.
• b) A specific sign-off, as quoted below, from the investors, for having understood the features and risks of the instruments, may be incorporated in the common application form of the proposed issue: "By making this application, I / we acknowledge that I / we have understood the terms and conditions of the issue of [Name of the share/security] being issued by [Name of the bank] as disclosed in the Prospectus and Offer Document".
• c) UCBs shall ensure that all the publicity material / offer document, application form and other communication with the investor should clearly state in bold letters (Arial font, size 14, equivalent size in English / Vernacular version) how a PNCPS / PCPS / RNCPS / RCPS / PDI / LTSB, as the case may be, is different from a fixed deposit, and that these instruments are not covered by deposit insurance.
• d) The procedure for transfer to legal heirs in the event of death of the subscriber of the instrument should also be specified.

8. Returns Banks should furnish to the respective Regional Offices annual return indicating (i) capital funds, (ii) conversion of off-balance sheet / non-funded exposures, (iii) calculation of risk weighted assets, and (iv) calculation of capital funds and risk assets ratio. The format of the return is given in the Annex-IV . The returns should be signed by two officials who are authorized to sign the statutory returns submitted to Reserve Bank. Annex-II Guidelines on Issuance of Preference Shares A. Perpetual Non-Cumulative Preference Shares (PNCPS) eligible for inclusion in Tier-I capital UCBs are permitted to issue Perpetual Non-Cumulative Preference Shares (PNCPS) at face value to their members or any other person residing within their area of operation, with the prior approval of Reserve Bank of India (RBI). The UCBs shall submit the application seeking permission, together with the Prospectus / Offer Document / Information Memorandum, to the concerned Regional Office (RO) of the RBI. A certificate from a Chartered Accountant to the effect that the terms of the offer document are in compliance with these instructions shall also be submitted along with the application. The amounts raised through PNCPS shall comply with the following terms and conditions to qualify for inclusion as Tier-I capital.
9. Terms of Issue 2.1 Limits The outstanding amount of PNCPS and Perpetual Debt Instruments (PDI) along with outstanding Innovative Perpetual Debt Instruments (IPDI) shall not exceed 35 per cent of total Tier-I capital at any point of time. The above limit will be based on the amount of Tier-I capital after deduction of goodwill and other intangible assets, but before deduction of equity investment in subsidiaries, if any. PNCPS issued in excess of the overall ceiling of 35 per cent, shall be eligible for inclusion under Upper Tier-II capital, subject to limits prescribed for Tier-II capital. However, investors' rights and obligations would remain unchanged. 2.2 Amount The amount of PNCPS to be raised shall be decided by the Board of Directors of banks. 2.3 Maturity The PNCPS shall be perpetual. 2.4 Options

• a. PNCPS shall not be issued with a 'put option' or 'step up option'.
• b. PNCPS may be issued with a call option, subject to following conditions: The call option on the instrument is permissible after the instrument has run for at least ten years; and Call option shall be exercised only with the prior approval of Department of Regulation (DoR), RBI. While considering the proposals received from banks for exercising the call option, the RBI would, among other things, take into consideration the bank’s CRAR position both at the time of exercise of the call option and after exercise of the call option. 2.5 Classification in the Balance Sheet These instruments shall be classified as 'Capital' and shown separately in the Balance Sheet. 2.6 Dividend

The rate of dividend payable to the investors will be a fixed rate or a floating rate referenced to a market determined rupee interest benchmark rate. 2.7 Payment of Dividend 2.7.1 The payment of dividend by the bank shall be subject to availability of distributable surplus out of current year’s profits, and if:

• the CRAR is above the minimum regulatory requirement prescribed by RBI
• the impact of such payment does not result in bank's CRAR falling below or remaining below the minimum regulatory requirement prescribed by RBI
• the balance sheet as at the end of the previous year does not show any accumulated loss 2.7.2 The dividend shall not be cumulative, i.e., dividend missed in a year shall not be paid in subsequent years even if adequate profit is available and the level of CRAR conforms to the regulatory minimum. When dividend is paid at a rate lesser than the prescribed rate, the unpaid amount will not be paid in future years, even if adequate profit is available and the level of CRAR conforms to the regulatory minimum. 2.7.3 All instances of non-payment of dividend / payment of dividend at a rate less than that specified should be reported by the issuing UCB to the concerned RO of Department of Supervision (DoS), RBI. 2.8 Seniority of Claim The claims of the investors in PNCPS shall be senior to the claims of investors in equity shares and subordinated to the claims of all other creditors and the depositors. 2.9 Voting Rights The investors in PNCPS shall not be eligible for any voting rights. 2.10 Discount The PNCPS shall not be subjected to a progressive discount for capital adequacy purposes since these are perpetual. 2.11 Other Conditions 2.11.1 PNCPS shall be fully paid-up, unsecured, and free of any restrictive clauses. 2.11.2 UCBs shall also comply with the terms and conditions, if any, stipulated by other regulatory authorities in regard to issue of the PNCPS, provided they are not in conflict with the terms and conditions specified in these guidelines. Any instance of conflict shall be brought to the notice of DoR of RBI for seeking confirmation of the eligibility of the instrument for inclusion in Tier I capital. 2.12 Compliance with Reserve Requirements 2.12.1 The total amount raised by the bank by issue of PNCPS shall not be reckoned as liability for calculation of net demand and time liabilities for the purpose of reserve requirements and, as such, will not attract CRR / SLR requirements. 2.12.2 However, the amount collected from members / prospective investors and held pending allotment of the PNCPS, shall be reckoned as liability for the purpose of calculating the net demand and time liabilities and shall, accordingly, attract reserve requirements. Such amounts shall not be reckoned for calculation of capital funds. 2.13 Reporting Requirements UCBs issuing PNCPS shall submit a report to the concerned RO of DoS, RBI, giving details of the capital raised, including the terms and conditions of issue together with a copy of the Prospectus / Offer Document, soon after the issue is completed. 2.14 Investments in PNCPS and Advances for Purchase of PNCPS UCBs shall not grant any loan or advance to any person for purchasing their own PNCPS or the PNCPS of other banks. Further, UCBs shall not invest in PNCPS of other banks and shall not grant advances against the security of the PNCPS issued by them or other banks.